Bell curves -& your Portfolio. It is appraisal time!


It is appraisal time!. You heard it right and it is the annual appraisal time for your portfolio.
But for those who do not know what is a Bell curve, let us understand it first.
Let us consider 50 students in a class and measure their height. The data looks like this
Inline images 1
And if you plot the distribution on varying heights and the no of students,  using histograms and draw a curve, the curve will look like this
Inline images 2
This curve is known as Normal Distribution curve or simply Bell curve as it resembles the shape of a bell.
You will notice that the majority of the class in the middle range with in the orange color band and there are few people, who are shorter than the average of the class and some are taller than the average of the class. These are marked in yellow in the image.
In a distribution like this,  around 5 to 10% fall in the yellow band and they are known as outlier.
Similarly the portfolio you have will have stocks which give very good returns, which is on the right side of the image and there may be few stocks which are in the left yellow band and they may be giving negative return. These are the ones which pull down the overall return of the portfolio.
Appraisal system.
Many companies use this bell curve to fit their employees based on their performance. It is not necessary that the pattern may follow a bell curve like the above. But then, they force fit the performance and fit the employees into a bell curve.
Why do the do that?
a. the organisations want to reduce the average wage hike of the all the employees as a universe.
b. They want to reward the out performers very well and they may get wage hike in excess of 50 to 75% or may be more.
c. They identify the second best performers and say pay around 20 to 30%
d. The average performers get around 10 to 15% and
e. the under performers are the one on the left side yellow area, either get no increment or asked to leave the organisation.
The average hike in wages would be (0.15*75 +0.20*25+0.55*10)  which is 21.75%
The force fitting is hurting the individuals and slowly the companies are coming out of this system.
What has this to do with your portfolio.
Your portfolio of stocks may or may not follow a normal distribution like the above.
You cannot force fit the portfolio as the performance is not in your hands.
However you need to do an appraisal of your portfolio and identify the performers and non performers.
You must constantly move your portfolio  from the blue range to the green range. see image below
Inline images 1
Move your portfolio to the greener curve and this enhances your returns on the portfolio. A skewness to right is good for the portfolio and selection of good stocks will help you move right.
Do remember that keep aside your emotions. Remember
Opinions Confuse
Facts convince. 
Things to do can be summarised as below
a.  Take a look at your portfolio.
b. Find out portfolio returns and individual stock returns.
c. Try to map the distribution curve.
d. Unlike a Bell curve appraisal you cannot force fit the returns and churn the portfoio to improve the returns
e. Keep moving the greener pastures.
g. Do this once a year.
varadharajan VS

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